Our long-term outlook has not changed. The economic expansion in the U.S. and most other developed economies is intact and will remain so until credit conditions become much tighter than they are today. In our view, that lies some considerable time off, perhaps years. With earnings forecast to grow and stocks reasonably priced in relation to those earnings in the U.S. (attractively in most other markets), we expect the long-term uptrend in share prices, in place since the financial crisis lows of 2009, will reassert itself in the coming months.
However, for now, global equity markets remain in correction/consolidation mode. Tax-loss selling may be a factor in the final weeks of the year. That said, as 2016 progresses, we expect investors will have growing conviction that:
- Some stability has returned to the energy complex, permitting a more- con dent recalibration of earnings power and values in this important market segment;
- Global growth prospects are improving as concerns about a possible hard landing for the Chinese economy diminish; and
- The expansion in developed economies is sustainable and has further to run underpinned by constructive monetary policies We expect global equities to deliver all-in positive returns over the coming 12–18 months..
Source - RBC Wealth Management; see “Views Explanation” on page 3 for details.
- The S&P 500 rebounded 8.3% in October as fears about China diminished and commodity prices attempted to carve out a bottom. Since the August correction low, technology and energy have led the market, while industrials and consumer stocks have also performed well.
- Health care has lagged as the issue of drug price controls has caught the attention of some presidential candidates and the press. We view the biotech and pharma industries as well positioned for the next three to five years, but the drug pricing issue could hold back share prices and compress valuations further in the run-up to the 2016 election.
- The wide gap between S&P 500 earnings and revenue growth persists. While more companies have outpaced earnings expectations than usual in Q3, far fewer have exceeded revenue targets. Excluding the much-beleaguered energy sector, which could see earnings tumble more than 60% y/y, S&P 500 earnings are on track to rise 6%–7% y/y in Q3—not so bad. However, ex- energy revenues may only grow by an anemic 1.5%–2%.
- In this challenging environment, we continue to favor domestically oriented companies, growth stocks, and dividend growers.
- A muted growth outlook combined with a challenging environment for key commodities creates a difficult backdrop for Canadian equities.
- Bank shares, up from recent lows, trade at valuations that seem undemanding relative to historical ranges. Concern over slowing loan growth, pressure on net interest margins, and the risk of increasing credit losses remain key challenges. So far, life insurance companies have successfully navigated the recent turbulence in equity and credit markets. We continue to recommend a market weight position in Canadian financials, balancing attractive valuations with a challenging near-term outlook.
October Performance of Major Equity Markets and Indexes
Source - RBC Wealth Management, Bloomberg
Germany led the way followed by Asia. Canada’s TSX lagged due to heavy commodity exposure.
- We see opportunities in some of the high-quality names in the Canadian industrials sector. The surprise Liberal Party majority in the federal election came with a pledge to double infrastructure investments over the next decade. The additional spending should create a tailwind for some infrastructure, construction, and engineering companies and may have a noticeable medium-term impact on economic growth in some regions, in our opinion.
- While the energy sector enjoyed a small rally in October on the back of M&A activity and short covering, crude oil prices remain at depressed levels on concern over persistent oversupply. We see interesting long-term value in some of the well- capitalized, high-quality names, but advocate a nimble and prudent approach to investing in the sector.
- Overall, we remain market weight with a negative bias for Canadian equities.
Continental Europe & U.K.
- With the start of earnings season, we are looking for clues concerning the effect of China’s slowdown on earnings. With global growth expectations scaled back, forecasts in Europe (including the U.K.) have been trimmed recently, with expectations for the energy and materials sectors, in the U.K. in particular, continuing to decline. The consensus expectation is -3.9% y/y growth for the quarter. We would expect domestic companies’ earnings to show more resilience. Earnings for 2016 are expected to bounce and be up 9% in Europe and 6% in the U.K., according to consensus estimates.
- European Central Bank President Mario Draghi’s comments regarding the possibility of additional monetary stimulus in December helped weaken the euro. This weakness would be a welcome respite for exporters who have struggled with a strengthening euro since the spring. It could also boost investor sentiment in the short term. The flattening of the yield curve is of concern for financial companies, some of which could struggle to meet dividend expectations. We continue to like the pharmaceuticals sector, though we follow with interest the pricing debate in the U.S. We also see opportunities in the consumer discretionary and the telecoms sectors wherein regulatory fears are overdone, in our view.
- Asian equities continue to recover from the steep correction over the summer. The MSCI AC Asia Pacific ex-Japan Index has risen over 10% from its low in September and is down 3% in 2015. Price movements in mainland Chinese stocks have been relatively stable. Last month, the Shanghai Composite posted its first positive month since its dramatic correction.
- We downgraded our outlook for Asia ex-Japan equities to neutral in September, largely due to events in Chinese markets. However, we continue to note that a number of Asian equity markets are trading at low valuations even after the recent rally.
- Chinese authorities released a brief and general statement regarding the development of its 13th five-year plan. The government targets “medium-high growth” over the next five years with an aim to double GDP and per-capita income from the 2010 level by 2020. On October 23, Premier Li Keqiang said that China would need to achieve annual growth of 6.5% to reach the target. We expect a full version of the proposal to be published shortly and final approval in the spring. The Bank of Japan (BoJ) left monetary policy unchanged in October. Under the current program, the BoJ is purchasing approximately ¥80T ($660B) in assets per year. Even so, RBC Capital Markets forecasts the yen to decline versus the dollar into 2016, noting that further monetary policy expansion is not a necessary condition for further weakness in the currency.
- The Japanese authorities continue their battle to maintain inflation, which has been impacted by low commodity prices. The BoJ cut its forecasts for core inflation (which includes energy and excludes fresh food) for this fiscal year (ending in March) to 0.1% from 0.7%, and next fiscal year to 1.4% from 1.9%. The bank also pushed back its forecast for when its 2% inflation goal will be achieved. Excluding energy, the inflation data is more encouraging: prices rose by 0.9% in September (August: 0.8%).
- Sustaining price increases is a critical part of our thesis for Japanese equities. We maintain our positive stance. The TOPIX Index is up 10.7% in 2015, but saw a significant correction in August and September, falling over 18%. It remains 8% below its August high.